Hello Tracer Community,
Greetings from the sidelines! I first stumbled across Tracer through the AFR article last month, and have gone deep down the rabbit hole since then. While history is littered with the number of startups that have failed to deliver on their promise to ‘democratise finance’, I feel like Tracer DAO has a real shot at unlocking a new range of hedging tools to meet the risks and social issues faced by retail investors the traditional market has so far failed to provide.
I’d like to offer as a topic for further conversation the issue of licensing: fitting crypto-assets into our existing regulatory framework (I’m writing from a Australian perspective, but you can extrapolate more broadly) is something of a square-peg-in-a-round hole exercise, and will require legislative action to remedy. Fortunately, this process is already underway with the Senate inquiries into fintech and crypto-assets, but waiting upon government to take action within a commercial timeframe should never be the only option. At the very least, Tracer DAO should consider as an alternative the possibility of applying for an operating license under the current financial regulatory regime.
A number of benefits should flow from this exercise: a best-case scenario would see a clear pathway for Tracer DAO to acquire a license and its associated benefits, including enhanced legitimacy in the eyes of the regulators and the broader public. From this community’s public statements so far on the topic, I understand this to be a priority for Tracer DAO.
However, even if it is concluded that a license is not obtainable under current circumstances, Tracer DAO will have sharpened its thinking on what the future licensing regime for crypto-assets should look like. A licensing regime that is not fit for purpose, or that fails to accommodate the diversity of functions crypto-assets can be put to use towards would be a poor outcome for Tracer DAO: the fruits of this discussion will hopefully equip the community to diminish that outcome from eventuating.
So what would licensing for Tracer DAO look like under current circumstances? I’d begin with looking at licence classes currently available to conventional financial services providers, and aligning Tracer DAO’s functions under those licensing classes. I‘ve left the possibility of obtaining a credit licence off this list because I think it’s probably too far a bow to draw at this stage, but can see how applying for an ACL might make sense in the future.
That being so, I’d consider:
Financial Services Licence (FSL)
This licence would cover the provision of financial services, and of financial products (itself defined to be a financial service).
At first glance, Tracer DAO’s capacity to provide for financial products built upon smart contracts issued through its factory function would seem to fall squarely within the range of activities a FSL purports to cover. On reflection however, a better view would be to consider Tracer’s factory function to be one step removed from the provision of financial products. An accurate analogy would be that of a trade association developing template contracts for their members to use throughout the course of their business: to use a real life example, ISDA maintains the standard form contracts market participants base derivatives off, but responsibility for product (particularly when things go off the rails) sits the institutional bank or swap dealer who issues the product based off ISDA documentation.
There are a number of reasons why Tracer DAO should seek to avoid seeking a licence that better describes the activity undertaken the users of the smart contracts. If only out of self-interest, seeking a licence that describes a third party’s activity unnecessarily expands Tracer DAO’s scope of liability, an outcome detrimental to its long-term prospects and viability. Seeking to license Tracer DAO may not even make sense from regulatory perspective however, if it serves to obscure the entity actually responsible for the misconduct. Back in 2018, the Financial Services Royal Commission highlighted the dangers of a delegated or dispersed licensing model when it looked into the financial advice sector to examine rogue financial advisors employed under a ‘Corporate Authorised Representative’ operating under a delegated FSL. Not only was it difficult to ascribe the individual misconduct back to the FSL holder (nearly always a business entity whose relationship with the advisor was intermediated by the CAR), regulator powers geared towards punishing the licence holder through fines or revocation resulted in a narrow range of options with which to pursue the individual advisor.
The main takeaway from this is that Tracer DAO should seek to be licensed for functions it can actually control, as opposed to activities it happens to be adjacent to. To be clear, this conclusion doesn’t mean Tracer DAO can wipe its hands of any responsibility for how its smart contracts are used (not least, if it truly aspires to robust regulatory settings): what it does mean is that the checks and balances on how its smart contracts are used will likely need to be developed by Tracer DAO in-house, an area which has yet to be fleshed out in its explanatory details to date.
Market Licence (ML)
Alternatively, Tracer DAO may seek to obtain an AML to operate a market exchange for the financial products that utilise its smart contracts. In my view, this would seem to be the obvious option, as it would capture the majority of Tracer DAO’s functions without encroaching on the activity of the smart contract users, including the:
- Oracle frameworks (analogous to the tape function provided by conventional markets);
- A reputation system (essentially a credit rating system);
- Privacy-preservation and safeguards against front-running: these would typically be built into the operating structure and rules of any modern financial market place.
Holding an ML would place Tracer DAO squarely in the regulators’ sights (and I do mean plural, see below), with plenty of cautionary tales to demonstrate the consequences if Tracer DAO fails to meet the mark: at the time of writing, both Binance and Bitmex have been censured and marginalised by the FCA and the CFTC respectively, for charges related to running an unlicensed crypto-asset marketplace.
Even domestically, designating itself a crypto-asset marketplace would expose Tracer DAO to the RBA, as well as ASIC. More broadly, in light of the recent noises APRA has made as to conducting a post-mortem on Xinja, I’d expect increased scrutiny to be applied to fintech going forward. In short, Tracer DAO needs to have its shit together before applying for an ML.
Clearing and Settlement Licence (CSL)
It’s not clear to me whether this is a relevant option for Tracer DAO: given its smart contracts are self-executing, there shouldn’t be a need for an entity to be licensed for clearing and settlement functions. However, it’s possible that Tracer DAO would require a CSL to validate its role in developing the clearing and settlement functions of the smart contract.
Given that the CSL regime was developed based off the ML, if anything this strengthens the case for Tracer DAO to apply for a ML in the first instance: if the CSL is required, it should be able to leverage off the preparatory work undertaken to apply for the ML, if not apply for them at the same time. Otherwise, the consequences of acquiring a CSL mirror those associated with an ML: a high degree of regulatory scrutiny.
Let me know what you think!